Keeping Cash Safe

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Amid immense uncertainty, the conservation of cash is in full swing. Managing working capital tightly, “de-risking” cash investments, increasing credit lines — you name it, companies are doing it. In fact, many balance sheets are now brimming with cash.

In a study of 563 companies rated triple-B-plus to single-B-minus, Fitch Ratings forecast that total corporate liquidity in 2008 will increase 2.7 percent over 2007. With money still relatively inexpensive, spending has yet to take a hit. Nonetheless, many companies are treating cash — and access to it — as more precious than the supply would suggest.

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They are more risk averse when it comes to capital investment, for example (see “Capex Caution“). US Airways will cut capital expenditures this year by 24 percent, to $240 million. Similarly, after spending $300 million in capex over six years, Frank Gatti, CFO of Educational Testing Services (ETS), decided to slash $10 million (20 percent) from the company’s budget for software development. “We’re going into a period that may or may not have robust revenue growth,” he says.

Watching Working Capital

For ETS, which hasn’t borrowed since 1998, paying close attention to working capital — the assets applied to operations — is even more critical. ETS promotes that awareness in business-unit leaders by basing their compensation partly on working-capital consumption. If a unit’s receivables are higher than a set threshold, a pro forma adjustment to profits is made for calculating compensation. “It represents the opportunity cost of having money housed in accounts receivable instead of cash,” Gatti says.

Higher working-capital costs are also receiving renewed attention at $14 billion World Fuel Services Corp., which sells to maritime and aviation customers. Rising oil prices could sting the company on its inventory carrying costs, just as its cash balance has dropped due to the acquisition of AVCard, a credit-card outfit. “We are very focused on ensuring we’re not carrying a penny more of inventory than we need to,” says CFO Ira Birns. As of the fourth quarter, the company’s inventory was $103 million, down $11 million from the prior period. That represents two days of sales.

But at the strategic-spending level, World Fuel is not retrenching. Last December it took the opportunity to refinance a bank credit facility on the same or better terms. “We felt that the bull lending market was overdue for a correction,” Birns says. “My father used to tell me that when it’s there in front of you, take it.” The company doubled the size of its existing facility to $475 million and extended it to 2012. Then, it turned around and tapped one-quarter of that facility to acquire gasoline and diesel distributor Texor Petroleum for $104 million.

Given that money is still relatively cheap, operating with borrowed assets still makes sense for some companies. Herman Miller Inc. plans to use a recently increased credit facility for any short-term operating cash needs. The $2 billion office-furniture maker upped its syndicated, five-year revolver by $100 million, to $250 million, says CFO Curt Pullen. “We have purposely worked down our cash balances,” Pullen says. “We are not keeping a lot of excess cash.”

Looking Overseas

For other sources of liquidity, some companies can turn to foreign subsidiaries that are flush with retained earnings. Although the U.S. economy is flattening (if not shrinking), India is expecting 8.4 percent growth in gross domestic product and China 11.3 percent in 2008, by some estimates. “A lot of cash has already built up outside the U.S.,” says Robert Deutsch, head of global liquidity at JPMorgan Funds. Since the credit crisis began last summer, international money-market funds rated triple-A have grown to $661 billion from $474 billion, he says.

So it won’t be unusual to see a parent company borrow from a foreign subsidiary to meet an end-of-quarter bank covenant, says Greenwich Treasury Advisors managing partner Jeff Wallace. If the parent pays back the foreign sub within 30 days, the payout is not classified a “deemed dividend,” which has tax consequences.

After 30 days, however, taxes kick in. At Varian Medical Systems, a supplier of software and medical devices for treating cancer, CFO Elisha Finney refuses to foot a big tax bill to repatriate the company’s overseas cash. Varian’s balance sheet held $360 million in cash last quarter, but the bulk of the funds are in a Swiss subsidiary through which some international sales (accounting for 51 percent of revenue) flow. But Finney will repatriate some cash, more so this year than last.

Do No Harm

The corporate urge toward safeguarding cash is most evident in short-term investment choices. Lisa Rossi, global head of liquidity management for Deutsche Bank global transaction banking, has seen large companies increase their cash balances like “squirrels storing nuts.” As the federal funds rate falls, it’s simple enough to leave money in a primary cash account and sweep it into an interest-bearing account overnight. “It becomes more appealing to have cash and other liquid investments readily available,” she says. Comments CFO Birns: “Capital preservation and liquidity are clearly paramount here; yield is a distant third.”

Treasurers have lowered return targets for cash investments, in fact, from 4.9 percent to 3.7 percent over the past 12 months, according to Greenwich Associates. CFOs who opt for direct obligations of the U.S. government are happy with even lower returns. At ETS, Gatti is stashing cash in maturities of under 30 days and not even considering government-agency issues. The investment policy is unlike anything he has ever instituted in his 10 years as a CFO. The problems in the capital markets are “so complicated that we’re not in a position to sort it out,” says Gatti.

Companies in growth mode have to make some tough decisions. AdmitOne Security, a yet-to-be-profitable venture-funded firm, has cut back on selling, general, and administrative costs but not research and development. “If you burn through all your cash and haven’t hit a certain [revenue] growth curve [by the time of your next funding], then you’re in a world of hurt,” explains Chris Dukelow, CFO of AdmitOne.

The company publishes a variety of metrics in an effort to motivate employees to save money. To limit travel expenses, for example, it discloses the average monthly travel cost per field employee. “People start paying attention to what they’re spending,” Dukelow says. The company also publishes a quarterly metric of what percentage of new employees came from recruiters, because that’s a costly way to find talent, one that the company tries to limit to 25 percent of its hires.

What goes down will come up, of course. If only companies knew when. While irrational exuberance hardly seems like something companies will fall prey to any time soon, Wallace says CFOs should avoid the tendency to approach liquidity preservation and cost cutting under the assumption that the downturn will be short-lived. “The hope of a quick turnaround is really something that has to be watched,” he says. To paraphrase Milton, they also thrive who only save and wait.

Vincent Ryan is a senior editor at CFO.

Staying Liquid

Tips for managing cash during a downturn

Check and recheck the assumptions and data in the cash-flow forecast, to ensure the accuracy of the information. In a recession, for example, “sales forces hate to admit that they are not going to make their quotas,” says Jeff Wallace, managing partner at Greenwich Treasury Advisors.

Demand a detailed variance analysis when actual cash flow falls short, says Bob Baldoni, a partner and head of Ernst & Young’s global treasury advisory services. Was it because of slower collections? Milestone problems in a couple of large contracts? In addition, ascertain whether the shortfall will be made up next quarter.

Encourage quicker payment of accounts receivables by (1) not compensating salespeople until an order is paid for, (2) calling overdue customers when a bill is one day overdue rather than seven days overdue, and (3) using stop shipments with customers who haven’t paid.

Pool transaction banking accounts, says Lisa Rossi of Deutsche Bank. A large corporation that may have 300 demand-deposit accounts can aggregate them into one or more groupings under a “master” or “header” account. Matching accounts that are consistently in a debit position with those in a credit position reduces overdraft charges, Rossi explains.

Consider investing in money-market funds that adhere to the Securities and Exchange Commission’s 2a-7 regulations, because their objectives — safety, liquidity, and yield, in that order — match up with current investment goals, says Robert Deutsch, head of global liquidity at JPMorgan Funds. If rated by the rating agencies, such funds must have a weighted average maturity of 60 days or less.

Companies should invest in themselves by paying down revolver debt instead of storing cash in low-yielding instruments, says Wallace. That avoids “negative carry,” because the return on any investment will probably be
less than the interest owed on the debt. — V.R.